Yes, the Skills Gap Is Real

05/08/2014

Some American workers lack the skills necessary to compete in the modern economy, some firms can’t find workers with the skills they need, and that’s hurting the labor market, right? This seems like a relatively uncontroversial proposition.

Not so, says Paul Krugman, who blasts the suggestion that a “skills gap” explains anything about the weak labor market. His post is predictably shrill and overstated, but it raises a number of interesting points about what employers actually want and what the American economy can actually provide.

Business surveys and anecdotal evidence suggest that many employers can’t hire because their preferred candidates simply don’t exist — there’s a gap between what the company wants and what their applicants offer. This is, of course, always true to some degree (there is no perfect prospect), but many companies say the gulf is often so wide these days that they’d rather leave a position entirely unfilled.

As an economic proposition, this should raise some eyebrows: If the customer (in this case, the employer) wants a better product (labor), it should just pay more money.

Unsurprisingly, then, the objective evidence is mixed. A BCG study found that the skills gap explains 80–100,000 vacancies in high-skilled manufacturing — which sounds bit, but makes up only 8 percent of the jobs in that particular sector. Marc Levine of the University of Wisconsin has found that, at least in Wisconsin, “wage ‘growth’ also lags the national rate, [a] sign that there is no labor shortage here.” And a Federal Reserve study revealed that at least among construction workers, the skills gap explains little about the employment picture. Still, in survey after survey, American companies fret over the capabilities of the average worker.

Part of the confusion comes from the lack of a working definition of “highly skilled.” In many studies skeptical of the skills gap, “college-educated” is a proxy for highly skilled. Marc Levine argues, for instance: “There are plenty of available jobs for well-educated workers going unfilled in Wisconsin and Milwaukee, as employers supposedly can’t find ‘talent;’ yet, despite the availability of all these jobs for skilled workers, a growing number of the highly-educated are choosing to work in low-skill, low-pay jobs.” When manufacturers talk about needing skilled workers, however, they’re not asking for literature students, but people who can run a weld shop.

Still, the wage question lingers. If the skills gap is real, companies ought to pay their people more to close it. As Krugman, Levine, and others see it, the employers’ refusal to pony up the cash just shows that they’re lying. They’re complaining about something they could address, instead of talking about the real problem (low demand in the economy).

Though intuitive, this is a pretty odd position for Keynesian academics. In an economy where aggregate demand, in Krugman’s understanding, remains depressed, it’s easy to imagine an employer stuck at a wage ceiling. Profits are low, and the company’s customers can’t bear a price increase, so the company can’t afford to train a new worker or pay a skill premium. Every business has revenues (hopefully) and costs. Krugman and Levine are so obsessed with the revenue side that they miss an obvious point: Firms with low earnings need lower-cost employees if they’re going to hire at all.

This is, I suspect, a situation far too familiar to many Rust Belt manufacturers. In the Dakotas and other rapidly growing states, manufacturers and other companies can pay their people more money because their profit margins permit flexibility. In Ohio, Wisconsin, and Michigan, the margins are already razor thin, if not upside down. The skills-gap skeptics see the lack of hiring in the post-industrial Midwest as evidence that employers aren’t that interested in hiring at all, because demand is low. But it could also be evidence that those employers don’t have the cash to hire even if they wanted to — also because demand is low. Attracting talent from Texas gas rigs or training an unemployed machinist turns the bottom line from black to red, or from red to deeper red.

In other words, a weak economy manifests itself in a variety of ways, and one consequence is the inability of struggling employers to pay for premium labor. Fixing the economy sounds like a great idea, but that doesn’t mean reducing labor costs wouldn’t help, too. There are obvious ways to do this — from better preparing high-school graduates from the labor force to pushing more students into post-secondary options that might actually make them employable.

For now, the problem is hardly acute. Yet it’s telling that one of the reports Krugman cites predicts a full-blown crisis in the years to come. By BCG’s estimate, the skills gap is a small problem growing worse every day.

One culprit is an education infrastructure that cares little for developing the skills manufacturers say they need. Perhaps we should listen to them. Or perhaps we can tell businesses already struggling to keep their doors open that the crisis is all in their heads.